January 26, 2010 Year of Reckoning?

Volume 13 | Issue 1

While able to weather the downturn, global aviation might take a nosedive in 2010 and beyond.

The global economy took a series of devastating shocks in 2008-2009, resulting in the first year since World War II without economic growth.

Every major economy except China and India watched their economies shrink. All civil aviation market indicators suffered unprecedented drops, particularly for air cargo traffic and business jet utilization. However, with a few exceptions, the world’s aircraft industries have so far avoided the pain associated with this downturn. In fact, new aircraft deliveries continued their upward rise, almost uninterrupted since they began in 2003. But there’s a very strong chance that 2010 will be an inflection point, if not a year of reckoning for the industry.

THE LARGE JETLINER QUESTION
Large commercial jetliners represent about half of the total 2009 market for aircraft deliveries – $60.5 billion out of a total aircraft market worth $120.8 billion (in new deliveries alone). This represents a 10.1 percent rise over 2008, but that number is highly distorted by the impact of Boeing’s 52-day machinist strike in late 2008, which artificially reduced deliveries that year by over 100 jets.

In reality, jetliner production rates are treading water. But unfortunately, there are no air travel market health indicators that justify this record level of production. Passenger traffic is stabilizing after over one year of precipitous drops, but it remains 6 percent under the peak level seen in January 2008.

In addition, the International Air Transport Association anticipates $11 billion in industry losses in 2009, following nearly $17 billion in 2008.

Yet production rates remain at record high levels. A key enabler of these high production rates has been U.S. and European government export credit financing, which now assists with a record level of transactions.

This might be sustainable, but it clearly speaks to some fundamental weaknesses in the market, both in terms of demand and finance availability. Most of the 2009 deliveries financed by private banks and lessors were arranged before the credit crunch. While this crunch is easing, many key jetliner financiers remain under heavy pressure, particularly AIG’s ILFC unit, CIT, and the Royal Bank of Scotland.

In short, large jets are a lagging economic indicator. That market will avoid a downturn that’s commensurate with the horrors that befell the world’s economies in 2008-2009, but there’s no hope that the jetliner industry will avoid some kind of painful aftershock. The most likely scenario is that production cuts will begin in earnest in the second half of 2010.These cuts will primarily afflict narrow bodies – Airbus’s A320 and Boeing’s 737 families. Together, these families comprise over 55 percent of 2008/2009 deliveries by value, the highest level in decades.

Both of the two big jetliner primes face challenges through the downturn. If Boeing finally succeeds in flying its 787 Dreamliner and beginning deliveries in 2011, that will provide some level of insulation from the drop in narrow-body revenue. However, there are still major challenges and uncertainties associated with bringing this new product to market. As for Airbus, there’s no hope of additional revenue from an A380 ramp up. That product is marginally relevant in good times, and almost completely unwanted in a downturn. The major challenge for the company will be to keep funding development of the far more important A350XWB.

One part of the air transport business has already begun shrinking. The regional jet market, which spent the great 2003-2008 boom going exactly nowhere, began contracting in 2009. Given ongoing capacity cuts in the key North American market, there is a near certainty of further cuts in 2010, at least for the two big legacy producers, Bombardier and Embraer. Next year should see first deliveries of Sukhoi’s SuperJet, to be followed by China’s ARJ21.

While regional jets have suffered from a softened market, business jets have felt the full up-front impact of the downturn. While they usually are also a lagging economic indicator – deliveries lag corporate profits changes by about 18 months – this time the bottom half of the business jet market has fallen directly in line with the broader economy.

Richard Aboulafia is Vice President, Analysis, at Teal Group Corporation, comprised of a team of experienced analysts and service professionals and founded in 1988 to research and publish timely, accurate information on the aerospace and defense industry. Visit www.tealgroup.com; www.richardaboulafia.com.

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